Tired of Covid-19; thinking about the next “regime”

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31

WHOA!!! WTF!

The title of this thread starts with "Tired of Covid-19 . . . " So why did it morph into a discussion of covid-19.

Come on folks, staying on topic is alway desirable in on-line communities, and in moderated forums, off-topic posts are subject to deletion and persistent off-topic posting could lead to expulsion. P123 is not moderated so those issues don’t exist here. But as matter of basic etiquette, I think it’s fair to ask people to stop talking about covid-19 in this thread. There are others in which you can do it, and/or you can start new threads.

But as investors, there’s a more challenging issue. If you can’t keep a focus on something, what hope do you have to invest successfully in a market dominated by highly sophisticated folks who have massive technological resources and never lose focus for even a nano-second! The whole point of p123’s being able to empower you to invest against such a crowd is the way its tools can help you turn off the noise and focus on objective evidence; i.e. data. The human brain should never be turned off, but instead of allowing it to wander at whim, successful p123 investors control where it goes and doesn’t go.

As to one thing I’m doing right now to while away the social distancing is creating simple screens, so simple I don’t even need to save them, to see which stocks/ETFs are holding up through the crash (relatively speaking of course) and which rate well under ranking systems I like and use. I get the tickers into a watch list and then start going through stock/etf by stock/etf to see why its holding up and assess whether I think there’s something there for beyond the current mess. That’s how I’m combining my judgment and data-evidence to look ahead, and in so doing, possibly pick up cues as to how near- or not-near term I should be thinking.

You don’t have to do what I’m doing. Do your thing. But whatever your thing is, PLEASE GET THE COVID-19 DISCUSSIONS OUT OF THIS THREAD SO THOSE WHO WANT TO STAY ON TOPIC CAN DO SO WITHOUT HAVING RELEVANT POSTS SWAPED. Please ask Marco to delete your off-topic posts, or at least edit them down to an -x- so they can easily be skipped by those of us who care about the topic (actually, do that even before asking Marco to delete since it’ll save him time having to hunt down deletable posts; he’s go enough else on his plate.

32

I’m not sure what holds up well going down are the biggest winners coming back up.

Wouldn’t it be like any other crash? That the industries hit the hardest bounce back the quickest?

Hotels, for example. Won’t they come roaring back after we return to normal travel levels?

33

There might be some decent early rebound data available for those who analyze Chinese stocks. By doing so, some insight might be gained into sector impacts and early recoveries, etcetera, that might also apply to some extent to European and U.S. markets at the right time (whenever that is). I have avoided them so am ignorant of the information value, but China has thus far been much better at responding and their stocks likely reflect that.

34

After a quick compare it looks like there are 3 top SPDR’s for every major correction since 2008. These 3 are the only ones that consistently have less DD than SPY.

XLP Consumer Staples has been the best bet
XLU Utilities
XLV Health Care

35

Well, we need the Top SPDRs for the next big rally. For the downside it is too late.
The next rally will come. When? Nobody knows.
If you still have powder, keep it dry.

36

Werner,

Agree if I understand, I have been in exactly those for while (XLU, XLP and XLV). Buying a little SPY over the next little bit. Probably should be QQQ or XLK soon.

More on another thread. My apologies for responding on this thread (where the post was made).

Best,

Jim

37

That’s certainly something to think about. But we can go further.

One of the things we learned from past crashes is that life after the crash, although it recovers in the aggregate, is not quite the same. Sometimes, there are structural changes in society/politics/the market. Sometimes its a matter of seeing which companies in down-and-up industries fall by the wayside and never really reach the up-phase, because they disappear or are permanently weakened.

We can and do all have our high-level views. But one of the unique things a platform like p123 offers is the ability to do some further digging . . . At the individual stock levels. And nickel-and-dime screener can show you which companies are crashing less. But we have the advantage of being able to prequalify sorts like that using ranking systems we have or newly create that put some fundamental substance into the picture. And we can see which companies are defying or doing worse than narrow peer groups (it’s not just sector; we have sub-sector, industry and sub-industry). And we have those data panels (for more, see chapter 7 of the A to Z Guide).

This terrible time presents a great opportunity to step back from all the ways you worked before and to think about and explore new things. Another characteristic of crashes is that there are always some who come out on the other side better and stronger than they were went it turned bad.

Don’t feel pressured to put real money to work right now. (You don’t have to catch the absolute bottom. If the first 10%-20% of the recovery runs ahead of you, you can always do what most people do - lie and claim to have caught the bottom; that’s cool, believe me, you won’t be alone.) Create and track watch lists for as long as you feel unready to buy.

38

I just want to reiterate that Portfolio123 was originally built for the purpose of creating automated models that would reduce the hard work and emotional turmoil of discretionary stock-picking, and that there is considerable evidence that automated portfolio selection works better than discretionary portfolio selection, especially during and after crises. At the very least, you should, if you’re a stock investor, do what Marc has always advocated: develop a four-step system for buying and selling stocks. 1. Find potentially attractive stocks; 2. analyze these stocks; 3. buy the best of these stocks; and 4. sell stocks that have weakened from the same perspective. These can steps can all be automated using our tools. I worry that the quantitative point of view is being lost among so many threads that promote discretionary stock and ETF trading or guessing about the future of the market.

One of the essential aspects of a quantitative (or behavioral) world view is admitting what you don’t know. I have absolutely no expectations about where the market is going to go. I have no expectations about whether we’re going to see a zero interest-rate environment for the next two months or twelve years. I have no idea whether the value inversion we’ve been witnessing for the last two years is going to continue for the next two years or is going to vanish as soon as the current crisis abates. I know that there is a tendency for small-cap value stocks to outperform other stock categories in the twenty-four months following a crisis (defined by a 20% drop in the S&P 500). But that may not be the case with the present crisis.

While I can’t work with certainties, however, I can work with probabilities. It is more PROBABLE that stocks like NVS, MSTR, ABBV, and AMKR will do well than stocks like CARA, CVNA, WPG, ZGNX, and VSLR. It is more PROBABLE that stocks that rank highly on quality, value, and growth metrics will succeed than stocks that rank poorly. The purpose of Portfolio123 is to help you with all that.

Marc is right: it’s a fine idea to take the opportunity that this crisis represents to use our tools and rethink your processes. But don’t throw the baby out with the bathwater. If you have a quantitative strategy that has worked pretty well over the last five years, don’t throw it out now that it has crashed. Modify it, tweak it, improve it; think about what opportunities might arise; think probabilistically; and read, read, read, read, read. Take your best ideas and put them to use. Improve your domain knowledge. Experiment with different systems and strategies. Take advantage of everything that we offer.

39

Well said Yuval.

Taking emotions out is key and this is why we have spent years building models for. Now is the time to use them.

For those that do not have their own models, there are good “conservative” P123 free models here → https://www.portfolio123.com/app/investment/add-new?browse=1

Jerome

40

The next regime…

Haven’t we seen (or about to see) the end of the bond bull market going back to 1981? Long term treasuries bottomed at 2.1% in 1946, topped at 15.2% in 1981, and just hit 1% earlier this month.

If so, shouldn’t we expect a 30-40 year bear market in bonds? A rising interest rate environment.

Long term, as the cost of capital rises and high price-earnings multiples become less and less attractive compared to bonds, this is generally bad for stocks. The Dow earned 4.4% annualized from 1946 to 1981 in the last rising rate bond bear, and 9.2% from 1981 to the February peak during the bond bull.

Regarding bonds, short term treasuries do better than long term treasuries in rising rates. They mature far quicker, allowing repurchase at higher and higher yields. Long SHY, short TLT would probably work well except for those periods when bond yields fall. And yields will fall during stock corrections as investors will continue to turn to bonds as a safe haven.

Stocks that will do well during rising rates include banks and insurance companies. If rates are rising due to inflation, then commodity producers and basic materials companies should perform well.

Ultimately, I have a feeling we get inflation (or stagflation). Not from wage growth/increasing corporate & personal debt creating more demand than supply, but from supply destruction from a variety of factors resulting in more demand than supply. Plus too much liquidity in the system may or governments printing their way out of debt may lead to a loss of confidence in currencies.

On the other hand, Dalio projects interest rates to be sticky near 0% for awhile under MMT.

41

The federal government is going to be purchasing corporate bonds directly. So expect that to pop in the near term. However, fundamentally, there is still a huge amount of risk in those bonds.

During the Great Depression, small value (which had been down by 85% according to some measures) bounced back within a few years. That implies a huge upside for small value once the dust settles.

42

I’ve reached the same conclusion - thinking about the next “regime”. In the meantime, I’d like to make income while this market cycles up/down. I am looking for opinions and/or input on the following:

Background

  • P123 member since 2010
  • Retail investor – limited to a few hours on the weekend for R&D and an hour or so to execute trades on Monday. i.e. not a trader
  • Value oriented – lean towards Graham / Buffett principles
  • 2007 – 2008 – kept buying on way down until ran out of cash
  • 2009 – 2013 – waited for recovery and ultimately moved to cash
  • 2013 – 2017 – pivoted to selling put options on companies I would want to own, once assigned I would sell call options. I did this in preparation for the next crash
  • 2017 – 2019 – sitting in cash
  • 2020 – ready again to sell puts

I am testing a screen “BT MegaCap Options during CY20" (visibility = public) for large companies, not overvalued, low debt, ample cash flow, limited volatility, very limited downside based on historical backtesting (08/01/2007 – 03/06/2009, 7/1/2015 – 09/01/2016, 01/01/2020 – 03/29/2020), etc. I would have no issue owning these companies, but don’t want a repeat of 2008.

I’m limiting to a max. of 10 positions and plan to sell weekly put options (manually verifying, but wish P123 had a way to incorporate into the screen) due to what I anticipate is going to be volatile for some period. Basically, a flat line over time with enough (4-5) tickers per week.

The screen should give you an idea of what I’m trying to accomplish (inactive/active rules). I’d appreciate specific feedback on the screen (not philosophical on strategy, but practical on rules) and if there are other screens that are better or would augment this.

Appreciate your thoughts.

/brandon

43

I’d like to hope so! But let’s take a look at some of the reasons people have given for small value underperforming: low interest rates, low inflation, tons of dumb money sloshing around the markets, value factors having been arbitraged away, the boom in cap-weighted index funds. In the post-vaccine regime, will any of those be different?

44

[quote]

I’d like to hope so! But let’s take a look at some of the reasons people have given for small value underperforming: low interest rates, low inflation, tons of dumb money sloshing around the markets, value factors having been arbitraged away, the boom in cap-weighted index funds. In the post-vaccine regime, will any of those be different?
[/quote]Who are these people? Where were these people a few years ago predicting large cap outperformance? Why should (1) low interest benefit large growth (that don’t need to borrow) more than small value (which need to borrow). Why should low inflation (2) help lg? Dumb money (3) chases past performance, but why was past performance of large growth so good? When will the dumb money chase small value? If value factors have been arbitaged away (4), how does that explain the factor reversal of value factors (where higher ranks made progressively lower returns), shouldn’t arbitrage make the ranking system backtest flat? How did the boom in index funds (5) create a bubble?

I consider people who have predicted all this in advance more credible than those who try to make sense of what happened after the fact and try to push a narrative. Ken Fisher is on record as predicting large growth outperformance a few years ago. He nailed it.

Largely because of Ken’s influence, I predicted long term large cap outperformace back in 2012 (not because he called it then, but I applied his principles). You don’t find me making too many market calls because there is high uncertainty, so when I do make a prediction I like to be right. I predicted the bottom in Spring 2009 back in November of 2008, and again I confirmed it in 2009 the day after it happened. I called for large cap performance back in 2012, and I called the bottom in 2018 the day after it happened. Unfortunately, I didn’t call the 2011, 2018, or 2020 tops, and my clients took a hit. I have had more success calling bottoms.

Here is my 2020 prediction. Small value, and in particular Asian small cap value, is highly likely to rebound much faster than large caps once this market bottoms.

Why?

My theory is that two factors drive relative performance: (1) fundamentals and (2) momentum.
(1) Fundamentals come in two flavors (1a) risk and (1b) reward. Fundamentals risk (1a) is the business quality. It includes factors such as growth, financial strength, ROE, etc. Reward (1b) is valuation; as defined by the price paid vs. the future cash flow of the business.
(2) Momentum (i.e. “dumb money”) also comes in two flavors, past risk 2a, (volatility) and past reward (2b).

Why did I call it in 2012? Why am I calling it now?

In 2012, valuations (1b) and business quality (1b) favored large caps, but past performance (2) still favored small value. Starting about 2014, the favorable large growth fundamentals started propelling large growth ahead of small value. Once the market volatility in 2011, 2015, and 2018 exposed more price volatility in small value over large growth, large growth looked favorably from a past risk (2a) point of view, and finally from a past reward (2b) point of view. At that point large growth had all four factors going for it.

Then, in 2018, the new tax laws boosted earnings of large growth (think repatriating foreign earnings). Enter the “dumb money” in 2019 chasing large growth and propelling large growth past small value and beyond reasonable valuations. Now, in 2020, the very real risk of bankruptcy to many small caps is pushing valuations of small value even further down. Once analysts are able to quantify the bankruptcy risk of various stocks, I expect small cap value to bounce back in a big way. In particular, small cap value in countries such as Korea, Singapore, and Japan that started with lower valuations and are coping relatively well with COVID-19 have the best fundamentals (1a and 1b) right now, and should start to see past outperformance which will attract 2, dumb money (i.e. past performance chasers).

I really really really would like to see international data be implemented in time to ride the current regime of Asian stocks!

45

Are we missing the trees for the forest?

Sure shutting down a company for 3-6 months will affect the company. How much? Maybe less than you think if you use the DDM or discounted cash flow. Maybe you can get a ballpark number on that. Maybe the stock—and the economy as a whole–will be impacted less than you would think.

There will eventually be companies—of all sizes—handing out dividends big enough that you would be a fool not to buy their stock no matter what theology you follow.

Still something is going on with small-cap value. The forest is different—there has been a change no matter what you want to call it.

I would add to the above possible reasons: barriers to entry and the government bailouts. Try to start your own manufacturing company to compete with Boeing (barriers to entry). Try to get the same guarantees from the US government and the Fed that your small business will still be here in 6 months and that you will not have some competition from some other startup if you are (government bailouts and barriers to entry). Try to get the Fed to buy your corporate bonds and imply that it may even buy your stocks to keep you in business (uhhh, crony capitalism).

Maybe someone kept track better than I did on who got bailed out in 2008 and 2009. But that was the past. Now we are told out front that they will do “Whatever it takes.” Whatever it takes if you are too big to fail, live in the right congressional district or are in an important industry that has a large barrier to entry.

For whatever reasons (good and bad) we are not going to let Boeing fail and see if Mark Cuban wants to start an aerospace manufacturing business.

I think I will be with large-caps for a while. Probably too long. Someone will have the common sense to pay $5.00 for an equity with an annual dividend of $1.00 (no matter its size) before I do.

Best,

Jim

46

A few of these questions are ones that I’d like to have an answer to too. In the context of the models for this site specifically the reversal of value factors and what triggered it I think should be a critical question for those who have used the small cap models developed on this site. I don’t know about you guys but the dependable small cap models I had followed for years could no longer be tweaked to produce a positive result in 2019. Instead quality factors were the flavor of the day. The change was pretty abrupt from what I could tell. What changed? I don’t know and I had to take a break as a result. Does anyone have an explanation?

Taking a step back though and looking at the broader market, explaining the outperformance of large caps I think is easier. Business cycle theory should explain some of it. Also the phenomenon behind the rise of the 1% in comparison to the 99% is the same in the stock market. A few large companies are capturing the bulk of growth in the economy.

47

I think small caps have significant competitive disadvantages

  1. They hire mostly Americans. Higher wage for less output compared to a globalist S&p 500 firm.
  2. They lack economies of scale in the digital age. While companies like KO can make use of all the latest SaaS tools and data analytics , the small/mid cap doesn’t have the budget/tech know hows.
48

[quote]
shutting down a company for 3-6 months will affect the company. How much?
[/quote]Ummm…Bankruptcy?[quote]
I think I will be with large-caps for a while. Probably too long.
[/quote]You are not the only one who behaves this way. Hence, style momentum. My background is value investing and I don’t mind being early if the reward is great enough and the risk is negligible. It worked for me during the GFC.[quote]
I think small caps have significant competitive disadvantages
[/quote]They always did. Yet small caps have outperformed by about 1% a year over the long term. So that doesn’t explain recent large cap outperformance.[quote]
the dependable small cap models I had followed for years could no longer be tweaked to produce a positive result in 2019. Instead quality factors were the flavor of the day. The change was pretty abrupt from what I could tell. What changed?
[/quote]Ken Fisher predicted that quality would outperform. I have been around long enough to remember a similar factor reversal in 2007 (at the start of the GFC). I have been anticipating a bear market this year but not this fast.

49

Chaim, this is a fascinating discussion indeed. Do you have any links to the Ken Fisher writings you’re talking about?

50

Unfortunately, most of Ken Fishers research is being drowned out by negative publicity that he got himself into, and I am having a hard time finding links. Furthermore, in general he has been correct about 60% of the time, which, while being a far better track record than most “gurus”, means that his recommendations are not always actionable out of context.

Having said that, his reasoning a few years ago was that the latter stages of bull markets are generally dominated by momentum.